Friday, September 23, 2011

From the left to the right, political commentators are piling onto Texas Gov. Rick Perry for calling Social Security a "Ponzi scheme." Perry's competitors for the Republican presidential nomination are overjoyed at an opening against the new front runner, with former Massachusetts Gov. Mitt Romney calling Perry "reckless and wrong on Social Security." Mr. Romney's campaign alleged that the Texas governor "believes Social Security should not exist." Even the ordinarily white-hot conservative Michelle Bachman has gotten in on the act, calling it "wrong for any candidate to make senior citizens believe that they should be nervous about something they have come to count on."

Perry has responded with a USA Todayop-ed on Social Security, stressing the need to reform the system. But, like another recent Texas Governor, Perry has the weakness of saying what he thinks without adequately explaining what he says. This doesn't mean he's wrong – as I'll explain, there's a lot that's right about Perry's claims – but it unnecessarily exposes him to attacks. That's why I don't call Social Security a Ponzi scheme; incendiary language can cloud whatever substantive point you're trying to make. Nevertheless, I'll try to sort a few things out.

To begin, Perry questions whether the Framers would even have considered Social Security to be constitutional. This sounds a bit wacky in today's context, but his claim is almost certainly true. Even the Roosevelt administration was worried that Social Security wouldn't pass constitutional muster, going so far as to delink taxes from benefits – that is, to eliminate the ownership right in benefits that Roosevelt thought so important – in order to bypass the objection that the federal government had no constitutional authority for a federally-run insurance plan.

As the Social Security Administration's history of the constitutional question makes clear, even this may not have been enough to get the Social Security Act passed by the Court without a little bit of Presidential intimidation. Prior to the Social Security case, Roosevelt threatened to "pack the Court" with additional Justices more to his liking. Roosevelt's plan failed but, as the SSA history notes,

…the Court, it seemed, got the message and suddenly shifted its course. Beginning with a set of decisions in March, April and May 1937 (including the Social Security Act cases) the Court would sustain a series of New Deal legislation, producing a "constitutional revolution in the age of Roosevelt."

In other words, the Supreme Court ruling validating Social Security's constitutionality isn't exactly how any of us would like court rulings to happen. Nevertheless, as Perry has noted, this is water under the bridge now. He isn't (and shouldn't be) seeking to re-fight a 65-year old constitutional battle. But to think Perry's constitutional claims are wrong is, well, wrong.

But now to the Ponzi comparisons. To be clear, these aren't a Perry original. As Perry's campaign pointed out, Romney himself wrote that Social Security resembles a "fraudulent criminal enterprise." Which enterprise might he have been thinking of? Likewise, Senate Majority Leader Harry Reid called borrowing from the Social Security trust fund "embezzlement, thievery," saying that if he had done this in the private sector "I could be criminally prosecuted by the district attorney." So the Texas Governor is far from alone in his comments.

But why a Ponzi scheme? The distinguishing characteristic of a Ponzi scheme is its intent to defraud. Charles Ponzi, and his modern cousin Bernie Madoff, meant to rip people off. Whatever disagreements we may have over policy, no one believes that FDR meant to rip people off and neither do modern liberals who wish to maintain the program as is by raising taxes.

But when most people refer to Social Security as a Ponzi scheme, they're not thinking intent so much as effect. What makes the Social Security/Ponzi references so common is the similarity in the way they are financed. In both cases, early participants receive payments, not from interest on their own investments, but directly from inflows from later participants. If you were describing the mechanics of how Social Security's financing works, it wouldn't be illogical to refer to a Ponzi scheme, a chain letter or something similar.

The more important similarity draws from their funding structures, but is expressed in terms of the expectations they produce. Like a Ponzi scheme, Social Security paid early participants incredible returns on their money, because they contributed to the system for only a few years but received a full retirement's worth of benefits. A person who retired in 1950 received around a 20 percent annual return on the taxes he paid (which happens to be exactly the same return that Bernie Madoff promised to his investors). Put another way, that person received around 12 times more in benefits than he'd paid in taxes. That helps explain why Social Security became so popular: it was simply an incredibly good deal.

If you were born in 1950 and heard your grandparents say how much they liked Social Security, you'd be tempted to think you'll get the same sort of deal. But you won't: an average wage earner born in 1950 will receive around a 2.2 percent return from the system, which is less than what you could earn on guaranteed government bonds. A person entering the workforce today will receive only around a 1.7 percent return. In effect, Social Security's reputation is based off a deal that it can no longer deliver. Whatever good it did in the past – and it did do a lot of it, in terms of reducing poverty and helping the disabled and survivors, in the process undercutting Perry's claims that Social Security was "by any measure" a failure – it will do less of it in the future.

The biggest difference may be that Social Security can go on forever while a Ponzi scheme can't, but that's mostly because Social Security can force you to participate. If Bernie Madoff could find enough people willing to accept a 2 percent return rather than a 20 percent return, his plan could keep going indefinitely. With Social Security participation is mandatory, so as long as Congress makes the changes necessary to keep the system from going broke it can go on forever.

Which, in the end, is what Perry and the other Presidential candidates – including President Obama, I might add – should be talking about. Whether Social Security was constitutional and whether its pay-as-you-go financing structure is optimal, we've got what we've got. A differently-designed Social Security system in 1935 might have produced better outcomes today and in the future, but we can't turn back the clock. We have to deal with the system we have and figure out how to make it solvent and how to make it work better in the future. (For my part, I put together a proposal for AEI as part of a larger budget project for the Peter G. Peterson Foundation.) Instead of arguing about what's wrong with Social Security, we should be thinking about how to put things right.

Tuesday, September 20, 2011

This Thursday I'll be moderating an event at AEI surrounding the release of The Declining Work and Welfare of People with Disabilities by Richard Burkhauser of Cornell University and Mary Daly of the Federal Reserve Bank of San Francisco. Here's some info, followed by a short video promo. Click here to register – it should be good.

Disability policy in the United States is failing the disabled. Social Security's disability trust fund is projected to be insolvent in 2018, and the costs of our disability programs are rising at an unsustainable rate, yet the disabled are working less than ever before. Richard Burkhauser of Cornell, author of The Declining Work and Welfare of People with Disabilities (with Mary Daly, AEI Press, September 2011), offers a "work first" approach that has the potential to shrink caseloads, curb costs, and improve the economic outlook for people with disabilities. It builds on lessons learned from the mid-1990s welfare reform effort and the recent reform of Dutch disability policy. Encouraging work enables individuals to reap the benefits of a growing economy and lead happier, more productive lives. Ron Haskins of the Brookings Institution and David Wittenburg of the Mathematica Policy Institute will respond.

According to EBRI estimates, the percentage of private-sector workers participating in an employment-based defined benefit plan decreased from 38 percent in 1979 to 15 percent in 2008. Although much of this decrease took place by 1997, there have been a number of recent developments that have made defined benefit sponsors in the private sector re-examine the costs and benefits of providing retirement benefits through the form of a tax-qualified defined benefit plan. However, these plans still cover millions of U.S. workers and have long been valued as an integral component of retirement income adequacy for their households. In this paper, EBRI's Retirement Security Projection Model (RSPM) is used to evaluate the importance of defined benefit plans for households, assuming they retire at age 65. The paper shows the tremendous importance of defined benefit plans in achieving retirement income adequacy for Baby Boomers and Gen Xers. Overall, the presence of a defined benefit accrual at age 65 reduces the "at-risk" percentage by 11.6 percentage points. The defined benefit plan advantage (as measured by the gap between the two at-risk percentages) is particularly valuable for the lowest-income quartile but also has a strong impact on the middle class (the reduction in the at-risk percentage for the second and third income quartiles combined is 9.7 percentage points). The analysis also provides additional information on how the relative value of the defined benefit accruals impact retirement income adequacy. It should be noted that this analysis does NOT attempt to do a comparison between the relative effectiveness of defined benefit vs. defined contribution plans in providing retirement income adequacy; however, it does show that when the value of a defined benefit plan is analyzed for those without any future eligibility in a defined contribution plan, the impact on the at-risk ratings increases to 23.6 percentage points. In other words, for those households without future years of defined contribution eligibility, the presence of a defined benefit accrual at age 65 is sufficient to save nearly 1 out of 4 of these households in the Baby Boom and Gen X cohorts from becoming "at risk" of running short of money in retirement for basic expenses and uninsured medical expenses.

The PDF for the above title, published in the August 2011 issue of EBRI Notes, also contains the fulltext of another August 2011 EBRI Notes article abstracted on SSRN: "The Impact of Repealing PPACA on Savings Needed for Health Expenses for Persons Eligible for Medicare."

This article addresses the question of whether foreign sovereign wealth funds (SWFs) should serve as a model for the United States in managing the Social Security Trust Fund. The last ten years has seen a significant shift in the way countries manage public pension and social insurance reserve funds. Rather than invest solely in government bonds, many countries now use modern portfolio techniques to diversify assets and earn higher rates of return for their reserve funds. Even after considering the losses incurred during the 2007-2009 financial crisis, some funds have managed competitive returns. Well-run funds include those found in Canada, New Zealand, Norway and Australia.

Curiously, the U.S. has not followed suit even though the long-term benefits of a diversified portfolio are well-known. The reason for this economically irrational behavior is likely rooted in political beliefs about the role of government as an owner of private enterprise. Institutional studies suggest that the rules constraining government investment are not likely to change rapidly given the constraints of path dependence theory.

However, the U.S. has seen incremental change in terms of attitudes towards government ownership of private enterprise. Many states run venture capital funds and government employee pension funds have been successful as apolitical state investment entities. Moreover, attitudes towards foreign SWFs have shifted from fear and anxiety over politically motivated investments to a greater acceptance of sovereign investors as wealth-maximizing entities. Crisis also drives change. The Social Security Trust Fund is now expected to be depleted by 2036. Diversifying the Trust Fund could eliminate as much as 30 percent of Social Security's funding deficit and do so without raising taxes or reducing benefits.

Foreign sovereign wealth funds that were created for the purpose of funding national pension systems provide a model for the U.S. to form an independent entity that is apolitical yet able to be held accountable for its actions. As politicians grasp for solutions to Social Security's funding problems that minimize tax increases and benefit cuts, they should consider adopting the successful diversification models employed by other countries.

How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.

Owner-employees often establish and maintain pension plans, which cover only themselves and their spouses ("Owner-Employee Plans") to qualify for favorable treatment under the Internal Revenue Code of 1986, as amended (the "Code"). Qualified plans must have governing instruments satisfying the qualification requirements, must be operated pursuant to those instruments, and must file annual plan reports and annual individual reports of plan distributions. Many Owner-Employee Plans violate some or all of those requirements. Moreover, some recipients do not report benefit distributions.

Four modest changes would improve compliance with the Code requirements pertaining to (1) an Owner-Employee or his beneficiaries including a benefit distribution in his or her income; (2) an Owner-Employee older than 70 ½ receiving minimum distributions; (3) the governing instruments of an Owner-Employee Plan satisfying tax qualification requirements; and (4) an Owner-Employee Plan operating pursuant to its governing instruments.

First, individuals would be required to include on their Form 1040s the names of those pension plans, if any, whose contributions they deduct from their total income to determine exclude from their adjusted gross income.

Second, Owner-Employer Plan administrators would be required to include in their Form 5500-EZ the amount of the plan's distributions and the number of participants at least 70 ½.

Third, the instructions to the Form 5500-EZ would remind plan administrators of the Code requirements (1) to report individual benefit distributions to the Service and the recipient representative, (2) to make minimum distributions to participants older than 70 ½, and (3) to operate the plan pursuant to governing instruments that satisfy tax qualification requirements.

Fourth, the lenient compliance programs pertaining to violations of the annual plan filing or prohibited transaction rules would be extended to Owner-Employee Plans, the only qualified plans excluded from such programs. If the final change is not adopted, in many cases only imprudent Owner-Employee would file annual plan reports or include plan distributions in their income because such disclosures could make the Service aware of prior violations that the Owner-Employee, unlike other pension plan fiduciaries, may not be able to correct at minimal cost.

This paper examines the use of target-date funds (TDFs) by a consistent group of 401(k) participants in plans that offered them in 2007 through 2009. The consistent group of participants were those who were in a plan that offered a TDF in 2007, were in plans that were still offering TDFs in 2008 and 2009, and were still in the data source in 2008 and 2009. This study uses the unique richness of the data in the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project, which for each year from 2007-2009 had more than 20 million 401(k) plan participants from more than 50,000 plans across a spectrum of plan administrators. In this database in 2007, 67.3 percent of the plans offered target-date funds as an investment option. This study follows those 401(k) participants identified as being in plans that offered target-date funds in 2007 and remained in the database, if they continued to be in a plan offering target-date funds in 2008 and 2009. In 2007, of those participants in this database, 38.9 percent had at least some of their account balance in TDFs. By 2008, 42.6 percent had at least some of their account balance in TDFs, reaching 43.2 percent in 2009. Furthermore, 36.6 percent of this consistent group of 401(k) plan participants had some of their account balance allocated to TDFs in 2007 and 2008. Just over 35 percent of these participants had at least some assets allocated to TDFs in 2007, 2008, and 2009. Among participants who were identified as auto-enrollees in 2007, 97.2 percent were still using TDFs in 2008, and 95.7 percent used them in 2008 and 2009. While those not identified as auto-enrollees continued to invest in TDFs at a lower rate than those identified as auto-enrollees, there was a very high overall persistence rate in TDF use from 2007-2009: just over 90 percent. Of the consistent group of participants using TDFs in 2007, 36.9 percent had all of their account allocated to TDFs. The remaining 63.1 percent of those using a TDF had less than 100 percent of their allocation in TDFs. In 2009, slightly more participants (67.2 percent) had less than 100 percent of their allocation in TDFs. Among only those participants who had all of their account allocated to TDFs, a very high rate (83.0 percent) stayed at a 100 percent TDF allocation in 2009. Almost 13 percent of those who had a total allocation to TDFs in 2007 had an allocation lower than 100 percent (but not a zero) allocation in 2009. Only 4 percent of participants with a 100 percent TDF allocation in 2007 had stopped using them by 2009.

In 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) added outpatient prescription drugs as an optional benefit. When the program was originally enacted, it included a controversial feature: a coverage gap, more commonly known as the "donut hole." The Patient Protection and Affordable Care Act of 2010 (PPACA) included provisions to reduce this coverage gap. This paper examines the impact that repealing PPACA would have on savings targets for health care expenses in retirement. The estimates suggest that retirees with high levels of prescription drug use throughout retirement would see their savings targets increase roughly 30-40 percent were the coverage gap reduction in PPACA repealed. Individuals at the median (midpoint) level of prescription drug use throughout retirement would not see any change in savings targets. This analysis uses a Monte Carlo simulation model to estimate the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses in retirement. Estimates are presented for persons who supplement Medicare with a combination of individual health insurance through Plan F Medigap coverage and Medicare Part D for outpatient prescription drug coverage. For each source of supplemental coverage, the model simulated 100,000 observations allowing for uncertainty related to individual mortality and rates of return on assets in retirement, and it computed the present value of the savings needed to cover health insurance premiums and out-of-pocket expenses in retirement at age 65. These observations were used to determine asset targets for having adequate savings to cover retiree health costs 50 percent, 75 percent, and 90 percent of the time. Estimates are also jointly presented for a stylized couple both of whom are assumed to retire simultaneously at age 65.

The PDF for the above title, published in the August 2011 issue of EBRI Notes, also contains the fulltext of another August 2011 EBRI Notes article abstracted on SSRN: "The Importance of Defined Benefit Plans for Retirement Income Adequacy."

The present paper discusses issues of challenges of social security systems in Sudan. Following parameters advanced by ILO and UNCOSOC, those systems are analyzed. The conclusions focus on their applicability that faces axial difficulties mainly presented in the state of institutional interregnum facing the country. Moreover, it is important to revisit aspects of social cohesion that serves greater role in traditional social security in the Sudan.

The aging of populations and hampering economic growth increase pressure on public finances in many advanced capitalist societies. Consequently, governments have adopted pension reforms in order to relieve pressure on public finances. These reforms have contributed to a relative shift from public to private pension schemes. Since private social security plans are generally less redistributive than public social security, it can be hypothesized that the privatization of pension plans has led to higher levels of income inequality among the elderly. Existing empirical literature has mainly focused on cross-country comparisons at one moment in time or on time-series for a single country. This study contributes to the income inequality and pension literature by empirically analysing the distributional effects of shifts from public to private pension provision in 15 European countries for the period 1995-2007, using pooled time series cross-section regression analyses. Remarkably, we do not find empirical evidence that shifts from public to private pension provision lead to higher levels of income inequality or poverty among elderly people. The results appear to be robust for a wide range of econometric specifications.

Our country is in far worse fiscal shape than its $14 trillion -- and rapidly growing -- official debt suggests. Indeed, that figure measures just a small portion of the government's total liabilities. Why is that? The answer is there is no answer, and because there is no answer, the deficit is not well defined, says Laurence Kotlikoff, a senior fellow with the National Center for Policy Analysis.

Generational accounting is a well-established methodology to measure the burden of government on specific generations. A generational account for any given generation measures the generation's remaining lifetime net tax bill as a present value -- what the generation will pay net of what it will receive, all valued as of today. This amount has to cover the government's official debt plus the present value of all future government purchases of goods and services (discretionary spending). If it doesn't, the difference that's not covered is called the fiscal gap.

The U.S. fiscal gap, based on the Congressional Budget Office's long-term Alternative Fiscal Scenario, is nowhere close to the $14 trillion official debt.

Indeed, the U.S. fiscal gap is $211 trillion -- 15 times larger than the official debt.

This means that Congress and the president have been focusing on the molehill, not the mountain, in their recent contretemps over the debt ceiling.

With the retirement of the baby boomer generation, millions will turn to Uncle Sam for Social Security, Medicare and Medicaid benefits -- roughly $40,000, on average, per beneficiary per year. This means the fiscal gap will increase exponentially in the coming years. The fiscal gap needs to be zero for the United States' fiscal policy to be sustainable, says Kotlikoff.

Achieving this result via tax hikes alone would require an immediate and permanent increase in all federal tax rates (corporate, personal income, excise and estate and gift taxes) of 64 percent.

Alternatively, the United States could immediately and permanently cut all non-interest spending by 40 percent.

Reason Magazine has a new poll on public opinion on entitlement reforms. Not surprisingly, the poll finds that most people don't want to see their benefits reduced. However, Americans are more open to reform if they're assured that they'll receive back everything they've paid in. This seems to point to an opening.

However, two things stand in the way, in my view:

First, if you include interest at a reasonable rate (say, the Treasury yield) then there's no way that Social Security reform can give everyone back what they paid in. The system's underfunded by somewhere around $17 trillion, so reform ultimately will pay participants – present and future -- $17 trillion less in benefits than they'll pay in taxes.

Second, while it would be possible to reform Medicare in this way – Medicare is slated to pay people a lot more in benefits than those folks paid in taxes – the difference is so large that the cuts required to even benefits up to taxes would be pretty big. While people are open to simply receiving back what they paid I'm not sure they'll be as favorable when things are presented in a different context (such as the percentage benefit cut required to do that).

I'm all for these kinds of changes, since ultimately taxes and benefits have to match up. But as a political matter I think it will be tougher than it looks.

Monday, September 5, 2011

The Hoover Institution publishes an interesting article from Chuck Blahous, one of Social Security and Medicare's public trustees, outlining what he sees as important myths about the programs. These myths include:

We "only" have a healthcare financing problem, not a population-aging or senior-entitlement problem. Medicare's financing shortfall is therefore much bigger and more urgent than Social Security's.

Social Security does not and cannot add to the deficit.

Medicare's projected insolvency date is the critical barometer of its financial condition.

Social Security projections are conservative; a good portion of its projected shortfall might disappear on its own.

Social Security's projected solvency through 2036 means that beneficiaries have pre-paid their benefits through that date; any benefit changes, therefore, should be deferred until later.

Friday, September 2, 2011

The Brookings Institution presents "Rethinking Incentives to Save for a Secure Retirement"

Friday, September 9, 2011, 11:00 am — 12:00 pm

Hart Senate Office Building, Room 216, Washington, DC

Americans — especially low- and middle-income workers — are simply not saving enough for retirement. The current retirement income deficit—the gap between what Americans will need in retirement and what they will actually have—is well over $6 trillion. This gap will be insurmountable without a significant change to current tax policy to help incentivize more Americans to save for their own retirement.

On September 9, the Retirement Security Project at Brookings will host a briefing in collaboration with the Senate Special Committee on Aging to examine new ways to help Americans save for retirement without increasing government spending. A panel of experts on tax, retirement and budget policy will explore ideas to modify the tax incentives for retirement savings.

About me

I am a Resident Scholar at the American Enterprise Institute in Washington, where my work focuses on Social Security policy. Previously I held several positions within the Social Security Administration, including Deputy Commissioner for Policy and principal Deputy Commissioner. Prior to that I was a Social Security Analyst at the Cato Institute. In 2005 I worked on Social Security reform at the White House National Economic Council, and in 2001 I was on the staff of the President's Commission to Strengthen Social Security. My Bachelor's degree is from the Queen's University of Belfast, Northern Ireland. I have Master's degrees from Cambridge University and the University of London and a Ph.D. from the London School of Economics and Political Science. I can be contacted at andrew.biggs @ aei.org.